A Debt Trap is a situation where your capability to pay back the loans taken is severely impacted. Month on month your borrowings or liabilities increase and if ignored could reach a situation the outflow exceeds the income. Many people are not aware that they are falling into a debt trap and realize it only when they are neck deep into that.
Major Indicators / Reasons for a Debt Trap
- Wrong Credit or Loans : Taking loans without assessing repayment capabilities. I have seen situations where people have taken huge loans based up on a hike in salary in the next financial year or a forthcoming onsite assignment or even based on the retirement kitty due in the subsequent two three years. Beware, these are all based on certain conditions and that conditions may not happen at all or the amount would be much lesser.
- Lavish Lifestyle: Spending without considering the earning capability, Trying to follow the lifestyle of the neighbour or an immediate family member without looking into own income. These are perfect recipe for a debt trap.
- Revolving Credit: Almost all the credit card now a days are offering revolving credit facility wherein only 5% of the outstanding need to be paid back in the current billing cycle. This in reality is an interest rate of 34.48% per annum. The noose tightens and the victim gradually falls into a debt trap.
- Personal Loans: Though this can be taken for emergencies, personal loan when combined with other existing loans make a deadly combination to lead you into a big trap. Personal loan interest rates are much higher than a car loan or a home loan, though less than a credit card revolving credit percentage.
- Borrowing for Consumption: This is a sure shot sign where you are in a debt trap. You don’t have a control on your outflows and needs to borrow to keep you afloat every month. Critical situation, I would say.
Twelve Steps That Can Rescue You From Debt Trap
The impact of Debt Trap is so huge that people many a times fall into depression and also think of ending the life of themselves and family.
Though there is no easy way to come out of a debt trap but, with proper dedication, a few sacrifices and strict discipline can save you from the big debts you have fallen into. What should you do ?
- Take Control of Your Finances: Assess your income and expenses properly, note down all your income and expenses month by month. Take help of an expert financial planner for guidance if you are not able to make a headway.
- Control Your Lifestyle: The latest iphone may look tempting, but if you are not able to pay for it upfront in this situation, be happy with a low budget phone for your needs. Same rule applies everywhere. If an expense can be postponed without an impact, do it, if it can be avoided without an impact certainly do it.
- Do Away With Credit Card Spending: If you are not able to manage your credit card without revolving credit, better carry cash and keep the card at home or better return it to the issuer and cancel the same. Balance transfer with a higher credit limit may look lucrative, but comes with many hidden costs and if you cannot control your spending, avoid card completely.
- Target High Interest Loans: Evaluate all your liabilities, their interest rates and the respective tenure. See if you can pay back some of the loans, if you can, then pay off the high interest loans. Check out for all alternate options available to move your high cost loans to loans that offers you better rate.
- Take help of Family and Friends: Many a times, people are reluctant to approach near and dear for soft loans or interest free loans fearing a reputation impact. These are the best source of options if you are in a debt trap, however try to pay them a rate of interest which they would have got from banks if invested. This would be a win-win situation as you would be getting a finance at a lesser rate to pay off debts and they would not lose out on their interest.
- Consult with your lender: If you can restructure some of the loans, do it with a lesser interest rate or for a lesser EMI with a greater pay back period. This will give you a breathing space to pay off other high priority loans. There is also an option of negotiating a settlement with your lenders, but consider this as a extreme step as it would have a negative impact on your credit score.
- Encash your low interest investments: Use your low interest investments to pay off the debts which are of high interest. Make sure that you are not dipping into your retirement savings as those are supposed to be for your life after retirement and dipping into that can have a severe financial impact in the later part of your life.
- Garage Sale: With the emergence of OLX, Quikr and similar sites, selling off your unwanted stuff is not very difficult and can get you reasonably good resale value. The treadmill which you are using as a cloth-hanger (yes, you have to restart your running in the park nearby to keep fit), the old working mobile phone which you put in your draw when you bought a “state of the art one“, the old TV which you moved to the other room when you purchased a new high value TV, old computers, laptops which you rarely use… A bunch of similar items put together can get you a good value and can pay off either fully or partly your smaller loans or credit card debts.
- Step up your income: Explore other ways to earn additional income or increasing your current income. A couple of hours in imparting knowledge to a kid in the neighborhood can enhance your knowledge as well as earn a few thousands per month. A small business idea with your skill (and without capital) can provide a relief to you in managing your debts. I know a lady who got into a financial crisis (not due to debts, but other extra ordinary circumstances) dug into her grand mother’s recipes and started a small business of pickles and jams. She not only survived the crisis, now that is her main income.
- Emergency Fund: If you are in a crisis situation, dip into your emergency fund created for this purpose. Normally, you should create an emergency fund for all such kind of contingencies. Check Contingency Planning – Saving for a Rainy Day.
- Gold: You might have inherited or received as a gift some gold ornaments which is lying unused in the bank locker and you don’t have any intentions to use it in the near future. These can actually provide you some cash as idle gold does not give you high returns and incurs carrying cost of locker and insurance. Though some people have a reluctance in selling gold due to family sentiments, do what your brain says rather than the heart in case of crisis situations.
- Smaller Tips
- If you have a habit of impulsive shopping, prepare a list of items to buy from your super market and stick to that list.
- Carry cash, stash those debit and credit cards into the dark corners of your locker.
- Before making any purchase, ask yourself, “Do I need it?”, even if you need it, ask, “Do I need it NOW?”. “What is the impact of me postponing this purchase?”, “Is there any alternative ?”
- Reduce your eating out habits. Restaurants are places for easy spending. Cook at home, eat healthy.
- Use alternate options like walking to nearby places. Your body would enjoy and your finances will be better with lesser spending on health as well as commuting.
The best way always is to stay away from big debts. As Benjamin Franklin said, “Rather go to bed with out dinner than to rise in debt.”